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Sovereign Fund Growth Blurs Traditional Roles Sovereign Fund Growth Blurs Traditional Roles

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NJ Daily / ISSUE OF THE WEEK

Sovereign Fund Growth Blurs Traditional Roles

May 5, 2008

In recent months, policymakers have placed increased attention on the ever expanding funds that foreign governments are investing in a variety of instruments in the United States.

These same officials also have expressed concern over foreign companies looking to invest, purchase or merge with U.S. firms - particularly when links to foreign government or issues of critical infrastructure are present.

But others argue that the United States already has the overall legal and regulatory systems to handle the potential negatives of these investments -- and that this country should welcome the economic benefits of foreign direct investment.

 

Growing By Leaps And Bounds

The firm Global Insight predicted last month that so-called sovereign wealth funds have been growing at 24 percent annually for the past three years. They are expected to surpass the current economic output of the United States by 2015.

Combined sovereign wealth reached $3.5 trillion in 2007 -- the largest generator being China, according to the firm. Russia and Kuwait are next. And, according to recent news reports, two other countries with substantial population and/or wealth -- Saudi Arabia and India --are considering setting up sovereign wealth funds.

Douglas Rediker, co-director of the New America Foundation's Global Strategic Finance Initiative, noted that sovereign funds derive their assets from oil or trade imbalances that generate current reserves.

"Traditionally over the years, we and the IMF have been advocating that countries keep a significant amount of reserves to ensure they are protected from a rainy day. These countries did exactly what we and others advocated that they do," Rediker said.

But, he added, "at some point the reserves got so high" that the involved governments felt the need to diversify these reserves. As a result, "they are putting some of these into SWFs," explained Rediker.

Such diversification might be a natural step for cash-rich foreign governments -- but the very magnitude of SWFs is hard to ignore.

If these funds increase as much as some predict them to within the next decade, it could make these funds "the largest shareholders in many of the world's biggest companies that are today privately owned," Ethiopis Tafara, director of the Securities and Exchange Commission's Office of International Affairs, said in recent testimony before the Senate Banking Committee.

What is new "is their emphasis on investing in companies around the world, rather than just investing in foreign government bonds," he noted.

This means that "because of the growth in sovereign business [which is controlled by the government whose assets comprise a majority of its ownership], many more of the world's biggest public companies could be directly controlled by governments," he said. Rediker noted that most large utilities and former utilities abroad are government-owned -- or, until recently, have been.

Edwin Truman, a senior fellow with the Peterson Institute for International Economics, said he does not expect to see the increased use of SWFs globally to have "large impacts on financial flows or relative asset prices" over the next decade. But he warned that there is a risk of financial protectionism -- and that countries will waste their money in the rush to invest.

Developing Best Practices Guidelines

A number of experts have voiced support for international initiatives to address SWF concerns. The International Monetary Fund is currently working on best practices guidelines for countries regarding these funds.

In March officials from Abu Dhabi and Singapore met with Treasury Secretary Paulson to discuss issues surrounding SWFs, recipient country inward investment regimes, and efforts to develop best practices.

A recent report from the Organization for Economic Cooperation and Development calls attention to the economic benefits that sovereign wealth funds can bring to both the home and recipient countries. These investments stimulate business activity and create jobs in the recipient countries and help shield the investing countries' "economies from volatility in commodity markets," according to the OECD.

However, these funds also raise "legitimate concerns in recipient countries about protecting national security ... based on the uncertainty regarding the objectives of the investor and whether they are commercially based or driven by political or foreign policy considerations" such as access to dual-use technologies.

Capitol Hill Watching Closely

Despite recent congressional action on the subject, U.S. policymakers have continued to raise concerns over foreign firms seeking to invest in U.S. companies and the increased use of the SWFs.

In late February, for example, Rep. Thaddeus McCotter, R-Mich., called attention to a plan by a Chinese company to purchase the U.S.-based 3Com Corp. "It is the solemn duty of the United States government to protect our liberty from all threats; and CFIUS must again do its job and reject this latest threat to our cyber-security," McCotter declared.

Last month, Senate Banking Chairman Christopher Dodd held a hearing to examine government-owned funds. Senate Democratic Conference Vice Chairman Charles Schumer of New York and Sen. Evan Bayh, D-Ind., have questioned the lack of transparency on the part of the funds.

And a leading Republican, Senate Banking ranking member Richard Shelby, has expressed concern over the national security implications of the increase in sovereign wealth funds and foreign investment in this country.

Shelby believes the Banking Committee should continue to monitor the implications of SWF investment in the U.S., as well as the ability of regulatory framework to keep pace with these investments in a dynamic global economy, an aide said. He also requested a GAO report on SWFs late last year.

Regulatory Mechanisms Boosted

But a 2007 paper from the Heritage Foundation contended that while it seems "worrisome to some that foreign governments are holding ever larger amounts of U.S. debt and assets ... the likelihood that governments are doing this as a means to disrupt the U.S. economy is slim."

The paper also stated that the "most direct and least costly way to boost domestic savings and reduce America's reliance on foreign capital is to reduce the federal deficit and taxes on savings."

Some experts say that current U.S. policies already in place can help the country address concerns related to foreign investment. Recent moves have boosted the federal government's ability to review foreign entities looking to invest in U.S. industries -- by directing more attention to the security implications.

The interagency Committee on Foreign Investment in the United States was originally established in 1975 to evaluate the impact of foreign investment in the United States. Following an attempt in 2006 by a state-owned company - Dubai Ports World -- to assume control of operations at some U.S. ports, President Bush signed legislation that created new procedures and requirements for CIFIUS.

The new law requires CFIUS to provide specific information to Congress annually on investment cases where critical technologies could be involved.

The Treasury Department in April issued proposed regulations that would update the CIFIUS process. "These regulations reflect America's strong and continued commitment to safeguarding U.S. national security in a manner that reinforces the longstanding U.S. policy of welcoming foreign investment. The proposed regulations increase clarity and make additional improvements based on experience," said Assistant Treasury Secretary for International Affairs Clay Lowery.

The Treasury Department is requesting comments on the proposed regulations and held a public meeting late last week on the subject.

The SEC also has in place several rules that require disclosure of certain sovereign wealth fund and sovereign business activities.

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